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Unemployment and
Its Natural Rate
Copyright © 2010 Cengage Learning
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• What is the importance of labor on economy’s
productivity?
Input per worker defines output per worker
• How government could affect labor factor to
stimulate growth?
Through investment in human capital
• What are the problems with the development of
labor factor in the poor and highly populated
economies?
Stretching natural resources, diluting the capital stock, brain
drain
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Unemployment
A job loss means a lower living standard in the present, anxiety about the
future, and reduced self-esteem. People who would like to work but
cannot find a job are not contributing to the economy’s production of
goods and services.
These are the key issues concerning unemployment:
• How does the government measure the economy’s rate of
unemployment?
• What problems arise in interpreting the unemployment
data?
• How long are the unemployed typically without work?
• Why economies always experience some unemployment?
• How policymakers can help the unemployed?
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How Is Unemployment Measured?
• Unemployment may be measured in two ways.
• A monthly survey of households – the Labour Force
Survey in the UK; Current Population Survey in US.
• The claimant count.
• Based on the answers to survey questions, each
adult (aged 16+) is placed into one of three
categories:
• Employed
• Unemployed
• Not in the labour force
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How Is Unemployment Measured?
• Labour Force
• The labour force is the total number of workers,
including both the employed and the unemployed.
• A person is considered employed if he or she spent
most of the previous week working at a paid job
• A person is considered unemployed if he or she is
temporary layoff, is looking for a job, or is waiting
for the start date of a new job
• A person is considered not in the labor force if he
or she fits neither of the first two categories such as
a full-time student, homemaker, or retiree.
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Figure 1 The Breakdown of the UK Adult
Population in 2004
Employed
(28.4 million)
Adult
Population
(47.4 million)
Labour Force
(29.8 million)
Unemployed (1.4 million)
Economically inactive
(17.6 million)
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How Is Unemployment Measured?
• The unemployment rate is calculated as the
percentage of the labour force that is
unemployed.
Number unemployed
Unemployment rate =
100
Labour force
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How Is Unemployment Measured?
• The labour force participation rate is the
percentage of the adult population that is in the
labour force.
Labour force participation rate
Labour force
100
Adult population
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Figure 2 Unemployment Rate Since 1971
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Unemployment rate in OECD countries
according to a duration of unemployment
Less than 1-2
1 month months
3-5
months
6-11
months
12 or
more
months
2008 Q1
0.88
1.14
1.19
0.89
1.59
2008 Q2
0.93
1.17
1.23
0.94
1.53
2008 Q3
1.00
1.28
1.30
1.03
1.59
2008 Q4
1.00
1.42
1.55
1.14
1.60
2009 Q1
1.04
1.50
1.86
1.49
1.81
2009 Q2
1.05
1.53
2.00
1.82
1.99
2009 Q3
1.02
1.48
1.91
2.02
2.26
2009 Q4
0.96
1.48
1.87
2.01
2.48
2010 Q1
0.91
1.36
1.77
1.95
2.70
2010 Q2
0.91
1.33
1.69
1.83
2.83
2010 Q3
0.93
1.34
1.59
1.74
2.99
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Identifying Unemployment
The economy always has some unemployment
• The amount of unemployment changes from year to
year.
• The long-run rate of unemployment around which the
unemployment rate fluctuates is called the natural rate of
unemployment, and the year-to-year deviation of
unemployment from its natural rate is called cyclical
unemployment.
• Natural rate of unemployment is persistent but not constant
and varies across the various groups within the population
distinct by gender, color of skin, age and education.
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Table 1 The Labour Market Experience of Different
Groups
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Identifying Unemployment
Statistics on unemployment and labor-force participation
for various groups within the U.S. population:
• Women have lower rates of labor force participation
than men but once in labor force, women have similar
rates of unemployment
• Women’s role in US economy has changed dramatically
over the past century – after WW2: women 33%, men 87%;
year 1998: women 60%, men 75%
• Blacks have similar rates of labor-force participation
as whites, and they have much higher rates of
unemployment.
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Problems with Interpreting the
Unemployment Data
• It is difficult to distinguish between a person who is
unemployed and a person who is not in the labour force.
• More than 1/3 of the unemployed are recent entrants into the
labour force:
• Young workers looking for their first job
• Older workers who had previously left the labour force but have now
returned to look for work
• Discouraged workers, people who would like to work but have
given up looking for jobs after an unsuccessful search, don’t show
up in unemployment statistics.
• Almost 1/2 of all spells of unemployment end when the unemployed
person leaves the labour force.
• Other people may claim to be unemployed in order to receive
financial assistance, even though they aren’t looking for work.
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Duration of Unemployment
• Most spells of unemployment are short.
• Most unemployment observed at any given
time is long-term.
• Most of the economy’s unemployment problem
is attributable to relatively few workers who are
jobless for long periods of time.
Example: Suppose an unemployment office with
stable 4 unemployed each week, 3 of which
unemployed for the whole year, the 4th changes
each week.
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Explanation of Unemployment
• In an ideal labour market, wages would adjust to balance the
supply and demand for labour, ensuring that all workers would
be fully employed. In reality, however, there are always some
workers without jobs, even when the overall economy is doing
well.
• Unemployment in the long run can be explained as follows:
• It takes time for workers to search for the jobs that are best suited
for them. Frictional unemployment refers to the unemployment
that results from the time that it takes to match workers with jobs.
• Structural unemployment refers to the unemployment that results
when wages are for some reason set above the level that brings
demand and supply into equilibrium – minimum-wage laws,
unions, efficiency wages.
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Job Search
• Job search
• the process by which workers find appropriate jobs
given their tastes and skills.
• results from the fact that it takes time for qualified
individuals to be matched with appropriate jobs.
• This unemployment is different from the other types of
unemployment.
• It is not caused by a wage rate higher than
equilibrium.
• It is caused by the time spent searching for the
“right” job.
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Frictional Unemployment
Frictional unemployment is a result of:
• changes in the demand for labor among different firms
• sectoral shifts – changes in the composition of demand
among industries or regions
Frictional unemployment is inevitable because the
economy is always changing. It takes time for workers
to search for and find jobs in new sectors.
At least 10% of U.S. manufacturing jobs are destroyed
every year. 3% of newly hired workers leave a job a
month after starting because of mismatch.
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Public Policy and Job Search
• Government programmes can affect the job search time:
• Government-run employment agencies – collect and provide
information about job vacancies
• Public training programs – aim to ease the transition of workers
from declining to growing industries and to help disadvantaged
groups escape poverty
• Advocates of these programs believe that they make the economy
operate more efficiently
• Critics question the ability of government to disseminate the right
information to the right workers better than market does
• Unemployment insurance – offers workers partial protection
against job loss
• increases the amount of search unemployment and reduces the search
efforts of the unemployed but it may improve the chances of workers
being matched with the right jobs.
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Structural Unemployment
• Structural unemployment occurs when the
quantity of labour supplied exceeds the quantity
demanded.
• Structural unemployment is often thought to
explain longer spells of unemployment.
• Reasons for structural unemployment:
• Minimum wage laws
• Unions
• Efficiency wages
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Figure 4 Unemployment from a Wage Above the
Equilibrium Level
Wage
Labour
supply
Surplus of labour =
Unemployment
Minimum
wage
WE
Labour
demand
0
LD
LE
LS
Quantity of
Labour
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Minimum Wage Laws
• When the minimum wage is set by law above
the level that balances supply and demand, it
creates unemployment.
• Although minimum wages are not the
predominant reason for unemployment in the
economy, they have an important effect on
certain groups with particularly high
unemployment rates.
• Minimum wage laws affect only the least skilled
and least experienced members of the labour force.
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Unions and Collective Bargaining
• A union is
• a worker association that bargains with employers
over wages and working conditions.
• a type of cartel (i.e. group of sellers acting together
in the hope of exerting their joint market power)
• unions are exempt from the antitrust laws because
policymakers believe that workers need greater market
power as they bargain with employers
• In the early 1980s over half of the UK labour
force was unionized but this figure fell rapidly
over a few years.
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Unions and Collective Bargaining
• The process by which unions and firms agree on the
terms of employment is called collective bargaining.
• Under the threat of strike which would increase firm’s
cost more unions reach to agreements with employers to
pay higher wages than they otherwise would:
• A strike refers to when the union organizes a withdrawal
of labour from the firm.
• Workers in unions reap the benefit of collective
bargaining while workers not in unions bear some of the
cost.
• Union workers earn about 10-20% more than similar workers
who do not belong to unions.
• The differential declines as education level rises.
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Are Unions Good or Bad for the
Economy?
• Critics argue that unions cause the allocation of labour to
be inefficient and inequitable.
• Wages above the competitive level reduce the quantity of
labour demanded and cause unemployment.
• Some workers benefit at the expense of other workers.
• Advocates of unions contend that
• unions are a necessary antidote to the market power of firms
that hire workers.
• The company-town – a single firm that does most of the hiring in
a geographical region.
• unions are important for helping firms respond efficiently to
workers’ concerns and thus keep happy and productive
workforce.
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The Theory of Efficiency Wages
• Efficiency wages are above-equilibrium wages
paid by firms in order to increase worker
productivity.
• The theory of efficiency wages states that firms
operate more efficiently if wages are above the
equilibrium level.
• It may be profitable for firms to keep wages even in
the presence of a surplus of labour because high
wage raise the efficiency of a firm’s workers.
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The Theory of Efficiency Wages
• A firm may prefer higher than equilibrium wages:
• Worker Health: Better paid workers eat a better diet and thus are
more productive.
• This explanation is more relevant for firms in less developed countries
where inadequate nutrition is a more common problem.
• Worker Turnover: A higher paid worker is less likely to look for
another job.
• Worker Effort: Higher wages motivate workers to put forward
their best effort.
• Marxist idea of the “reserved army of unemployment”: employers benefit
from unemployed who help them discipline those workers who have jobs.
• Worker Quality: Higher wages attract a better pool of workers to
apply for jobs.
• Adverse selection: Equilibrium wage would attract only the incompetent
workers.
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Summary
• The unemployment rate is the percentage of those who
would like to work but don’t have jobs.
• The Office of National Statistics calculates this
statistic monthly in the UK.
• The unemployment rate is an imperfect measure of
joblessness.
• In the UK economy, most people who become
unemployed find work within a short period of time.
• Most unemployment observed at any given time is
attributable to a few people who are unemployed for
long periods of time.
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Summary
• One reason for unemployment is the time it takes for
workers to search for jobs that best suit their tastes and
skills.
• A second reason why the economy always has some
unemployment are the wages that exceed the equilibrium
level.
• Minimum wage laws raise the quantity of labour supplied
and reduce the quantity demanded.
• The market power of unions allows them to negotiate higher
wages for their members.
• The theory of efficiency wages states that high wages can
improve worker health, lower worker turnover, increase
worker effort, and raise worker quality.
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